“Prepare for the worst, hope for the best” is a common idiom. One of the big picture concepts within that idiom is to balance optimism and pessimism. We believe this concept applies to personal finance too.
Prepare for the Worst
Bad things happen. These unlucky events occur more often than we like, usually with the intensity and force far stronger than we expect. There are numerous examples. A recent example is the COVID19 pandemic that resulted in nearly 2 million deaths and damaged economies across the globe (e.g., the U.S. had a peak unemployment rate of approximately 39% due to COVID). Another example is the California wildfires that ravaged the state through most of 2020 and burned over 4 million acres, destroyed over 10,000 buildings, caused loss of life, and cost over $2 billion. These events impacted millions of people, and it’s truly a devastating thing – emotionally, mentally, and financially.
Unfortunately, we do not control these events. Again, bad things simply happen. The best we can do is prepare ourselves to the best of our capabilities, which means doing a couple of things.
- Save aggressively and set up an emergency fund. This action helps create a safety net for you to deal with the next crisis calmly and confidently. It provides you with some peace of mind in turbulent times. Common wisdom suggests that one has enough funds to cover six months of expenses. However, this is a personal choice, and you should aim to have enough funds to feel comfortable should everything go south (e.g., perhaps it might take up to a year to find a new job).
- Consider purchasing insurance to protect critical assets. Insurance may help lessen the impact of financial loss due to unforeseen events. If you own any assets (e.g., a house, a vehicle, a business), it may make sense to explore insurance policies that help cover unexpected damages.
Cloudy and rainy days occur. We can, and should, do a few things to help us weather the storm.
Hope for the Best
Once we make sure we can get through rainy days, we should invest like an optimist. The reason is that compounding is a serious force. In simple terms, compounding is when an investment generates returns, reinvests it, and generates more returns. It’s a virtuous cycle that magnifies returns and accrues value over time.
We can also think about the compounding concept in more real terms. Compounding can be regarded as cumulative progress over time from solving one problem to the next and building on that breakthrough. Incremental progress occurs in businesses, communities, and societies as we all work towards getting better and fixing our failures, and incremental progress builds over time. This characteristic of seeking to improve helps our economies grow. When we invest, we get to enjoy the long-term benefits from the progress-focused mindset of our economies.
We should certainly make sure that our investment approach and strategy make sense for our goals and preferences as we invest optimistically.
To conclude, as you build your personal finance plan, we suggest keeping the idiom “prepare for the worse and hope for the best” in mind.